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Our shrinking equity markets

One of the little-noticed features of the international capital market is that listed equity markets are shrinking around the world. This is true both in north America and Europe, and yet there has been hardly any debate about it – until now. The European Commission’s green paper on long-term finance provides an opportunity to question this trend as we seek to re-design our markets in the wake of the banking crisis.

To be promoting the equity market seems odd given that share dealers are supposed to be among the shortest of all horizons, especially when it comes to high-frequency trading. Yet while shares may change hands at breakneck speed, the capital that underlies them is truly long-term, because it never has to be repaid. Unlike private equity, there is not even a predetermined deadline where the providers of capital wish to cash in.

Equity capital is the bedrock of business. Without it, companies cannot invest and grow. Nor can they generate the returns needed to service their debts. The provision of affordable equity capital is thus critical to our ability to recover and grow.

In particular, Europe needs to consider how to develop pools of long-term capital incentivised, through fiscal or other means, to invest in equities. While two decades ago such incentives existed for both the insurance and pensions industry, these have been eroded through regulation such as the solvency directive. Now, European markets are relying too heavily on overseas investors to provide long-term investment.

The figures are stark. The number of companies listed in the UK fell to 2,845 last year from 3,579 in 2008. Figures from the Federation of European Stock Exchanges show that, in the same period, the number of companies listed on the Deutsche Börse fell from 858 to 740, while listings on Nasdaq OMX Nordic (Denmark, Sweden, Finland, Iceland and the three Baltic states) fell from 845 to 766.

Some observers believe this is merely cyclical. Very low interest rates have made it attractive for companies to raise loans instead of issuing new shares, and the market will revive naturally when interest rates revive, they argue. But there are also structural forces at work. These include the fact that debt is taxed more cheaply than equity, the growing costs of intermediation between the savers who buy shares and the companies who use the money they provide, and the regulatory burden imposed on listed companies compared with those that are not listed.

Structural aspects should not be ignored. Even though the equity markets have not recently been a source of capital for new investment, they played a vital role during the financial crisis, and we should see them as a source of capital for the future. Regulators should recognise this and not single out the listed market for a particular burden.

The Commission should examine the reasons for the declining participation of insurers and pension funds in equity investment, and the role played by solvency requirements in this. It should examine the costs inherent in the equity-investment chain and address those which are the result of market failure or misdirected regulation. Finally, it should seek to avoid legislation that places an unfair burden on the listed sector.

While recent initiatives on remuneration and boardroom diversity are legitimate and understandable, they single out the listed market for regulation even though high remuneration and lack of diversity persist in the unquoted sector.

An ability to access capital at reasonable rates will become increasingly important to Europe’s competitiveness as other fast-growing regions seek to obtain a greater share of limited supply. Global wealth is flowing to emerging economies. We need to consider how Europe can rebuild an environment in which investment can flourish.

Peter Montagnon is a senior investment adviser at the Financial Reporting Council, the UK’s independent regulator of the accounting, actuarial and auditing professions.